Essays in Financial Economics

Abstract

The first chapter provides empirical evidence of a financial channel through which a friction in the labor market impacts corporate investment in innovation. I document that employment protection amplifies operating leverage and reduces the ability of financially constrained firms to perform R&D projects. Using the adoption of wrongful-discharge protections by state courts across the U.S. as a source of exogenous variation in the cost of adjusting labor downwards, I show that it increases operating leverage of firms in these states. Among financially constrained firms, these court decisions reduce R&D investment, and amplify the procyclicality of R&D investment. Capital expenditures, however, are not affected regardless of the level of financial constraints. Last, I show that high R&D firms hoard cash and issue more equities in response to the court decisions. I provide a corporate investment model with costly external finance and liquidity constraints that predicts these patterns. The second chapter explores the implications for asset prices of shocks that raise the intensity of innovation for new product development. Innovation increases productivity by expanding product variety, but requires time and resources to be implemented and become available for production. Therefore, higher intensity of innovation is associated with larger investment and higher marginal value of consumption. Firms the values of which are more sensitive to the intensity of innovation, the growth firms, command lower risk premiums. Based on this observation, I build a calibrated general equilibrium model with time-varying intensity of innovation that can potentially explain the equity premium and the cross-sectional distribution of equity returns. I also provide empirical evidence of comovement between innovation intensity and the value spread. The third chapter proposes an alternative method to decompose market unexpected returns into cash-flow and discount-rate news by incorporating information from the cross-section of asset returns. I find that the resulting market news series are relatively stable to the choice of VAR variables that are used to generate the expected market return series. Furthermore, when I estimate the market cash-flow and discount-rate betas using the updated market news series, it shows a pattern across the characteristic-sorted portfolios consistent with the one initially documented by Campbell and Vuolteenaho (2004), regardless of the sample period. The cross-sectional goodness of fit of the ICAPM improves when it is tested using the market news beta estimates constructed based on the updated market news series. The out-of-sample construction of the market news series that incorporates the cross-sectional asset return information demonstrates that the market cash-flow news is much less volatile than previously estimated directly using the VAR models.